Why there is more than a 90% probability to a bearish stock market scenario

Are the guys rushing to switch from bonds to equities so far this year the first charge into a new secular bull market or the last into the old cyclical bull market rally? That’s what the smart money is asking on Wall Street this weekend. The positive newspaper headlines about stocks are so often a contrarian indicator.

Then again you can be more scientific than this. US fund manager John Hussman has more than a 90 per cent probability to a bearish scenario for stocks because the combination of the following key indicators is in place…

Bearish points

The S&P is more than eight per cent above its average for the previous 52 weeks, more than 50 per cent above its four-year low and trades well up on its historic average cyclically adjusted earnings multiple; treasury yields have risen over the past half-year and investor bullishness is way ahead of bearish sentiment.

Mr. Hussman notes that whenever all these factors have flashed together then in nine out of ten cases in the past 40 years there has been a correction in the stock market. That’s a more than 90 per cent probability of a bearish immediate stock market scenario.

It’s not that there will be no ‘Great Rotation’ from bonds back into stocks, just that it is unlikely to be a smooth process with no casualties, i.e. occur without a major stock correction as a part of the switch.

That’s what another wise head, Michael Hartnett of Bank of America is saying: ‘The two major risk scenarios to an orderly Great Rotation are: a bond market crash as in 1994; or a risk shock as in 1987 driven by a currency war.’

Will it be any different this time? ArabianMoney would argue yes, this time it could be much worse. Was not the scale of the global financial crisis of 2007-9 and the Great Recession much bigger than what happened in those two other recent events? Was the Fed policy response not unprecedented? Why should the aftershocks therefore not be that much greater too?

Go-Stop economy

George Soros’s lecture at the World Economic Forum last week propounded his view that we are now in a ‘Go-Stop’ global economy that he thought was much better than only being on Stop though clearly with heightened volatility and considerable risk. How does that square with an always up stock market and present investor complacency? It’s a bull trap surely.

Beware the pushing of the Stop button and a plunging stock market. That might indeed be followed by the mother of all rallies to new stock market highs and beyond (with renewed money printing by the central banks) but the Fed currently seems to be growing wary of adding more fuel to the fire under financial markets.

Listen to what the smart money is saying and that 90 per cent probability of a bearish immediate stock market scenario is not nearly so unbelieveable.

2 Comments posted by readers:

Comment by Bernard M.A.Doff - 27 January 2013

Yes, the Great Rotation from bonds to equities is underway. The doom-mongers from 2012 like Mr Roubini are preparing their alibis. Probably they will lock on to the next correction to “prove” their hugely wrong negative forecasts, then nimbly switch to a more positive world-view.

Comment by H. CRAIG Bradley - 26 April 2013

BULL/BEAR DEBATE

I take this prediction as an immediate contrarian signal, that is we are going up some more before a “correction” happens. Everybody these days has an opinion, big or small. There is more money yet on the sidelines and we first need the ’suckers’ to throw some of their money at already pricy dividend stocks. Next up are the cyclicals who will then take the lead, followed possibly by a “crash”. Its Casino Time.

Everyone keeps repeating one of two messages: A 16,000 DOW by 2014, or the opposite: A “market Crash” in the second half of 2013. I say neither for now. We all know when interest rates begin to increase its ALL OVER. That’s when the trouble starts. It may not just be a bear market when its all said and done. It could be even worse, as in financial collapse. There are some in this camp to (Armageddon).